Agricultural Marketing ECON 337: Agricultural Marketing Chad Hart Associate Professor chart@iastate.edu 515-294-9911 1

Option Premiums Can be divided into two sections: Intrinsic value What is the option worth today? Time value How much time is left on the option? Intrinsic value depends on the futures price and the strike price of the option. Time value depends on the length of time in the option and the price volatility in the market.

Option Premiums Intrinsic value will not be less than zero. Remember, you have the right to exercise an option, not the obligation. So if the option is losing money, you can just let it expire. Time value will gradually approach zero as the expiration date approaches. Option premium = Intrinsic value + Time value

Example Start with an December 2017 corn put option @ $3.90 per bushel Day Futures Price Option Premium Intrinsic Value Time Value 1 $3.855 $0.32375 $0.045 $0.27875 2 $3.8725 $0.31125 $0.0275 $0.28375 3 $3.9625 $0.27375 $0.00 4 $3.945 5 $3.9325 $0.29125

Combination Strategies Option fence Buy put and sell call Put spread Buy In-the-money or At-the-money put and sell Out-of-the-money put

Option Returns in a Fence Buy Put Option Dec. 2017 Corn @ $3.50 Premium = $0.10625 Sell Call Option Dec. 2017 Corn @ $4.50 Premium = $0.14625

Fence for Speculator Buy Put Option Dec. 2017 Corn @ $3.50 Premium = $0.10625 Sell Call Option Dec. 2017 Corn @ $4.50 Premium = $0.14625

Fence for Hedger Buy Put Option Dec. 2017 Corn @ $3.50 Premium = $0.10625 Sell Call Option Dec. 2017 Corn @ $4.50 Premium = $0.14625

Option Returns in Spread Buy Put Option Dec. 2017 Corn @ $4.50 Premium = $0.6975 Sell Put Option Dec. 2017 Corn @ $3.50 Premium = $0.10625

Spread for Speculator Sell Put Option Dec. 2017 Corn @ $3.50 Premium = $0.10625 Buy Put Option Dec. 2017 Corn @ $4.50 Premium = $0.6975

Spread for Hedger Sell Put Option Dec. 2017 Corn @ $3.50 Premium = $0.10625 Buy Put Option Dec. 2017 Corn @ $4.50 Premium = $0.6975

Combination Strategies Butterfly Straddle Condor Strangle These positions can be flipped

Condor Sell Put @ $3.00 Premium = $0.0175 Sell Call @ $6.00 Buy Put @ $4.00 Premium = $0.3425 Buy Call @ $5.00 Premium = $0.07875

Condor for Hedger

The 4 Basic Graphs for Options Buy a put Sell a put Buy a call Sell a call

Class web site: Have a great weekend! http://www.econ.iastate.edu/~chart/Classes/econ337/Spring2017/ Have a great weekend!